The CPA’s Intro to Hemp and CBD Accounting
To serve one of the fastest growing industries in the country, CPAs must understand how accounting for hemp and hemp-derived CBD is different—and why it’s a great growth opportunity.
Cannabis, CBD, hemp, marijuana, THC. You’ve surely heard all
these terms by now, but in order to fully grasp and understand
accounting for the fast-growing hemp and hemp-derived CBD
industries, you need to know the different characteristics of the
Cannabis plant and the laws governing its growth and distribution.
Wrap your head around this: hemp and marijuana are both derived
from the Cannabis sativa L. plant. So, while both are technically
cannabis, the first major difference between hemp and marijuana
that you should note is that non-drug hemp or industrial hemp
was federally legalized under the 2018 Farm Bill while marijuana
remains a federally illegal drug under the Controlled Substances
Act. Why is that?
First, industrial hemp is bred to have a low concentration of THC
(0.3 percent or less, per section 10113 of the 2018 Farm Bill), or
tetrahydrocannabinol, which is responsible for the psychoactive
effects of cannabis when used as a drug (which may have THC
levels exceeding 30 percent). Second, industrial-use hemp has a
high concentration of cannabidiol (CBD), which decreases or
eliminates THC’s psychoactive effects. In short, legal hemp can’t
get you high and its industrial and commercial uses reach far and
wide—think paper, textiles, fuels, edibles, oils, pain relievers, and
more. In fact, archaeologists suspect hemp was the earliest plant
cultivated for textile fiber and the oldest example of human industry.
Fun fact: Hemp cord was found in an ancient village dating back
more than 10,000 years in a region we now recognize as Taiwan.
Today, hemp and hemp-derived CBD are experiencing a
renaissance. But what does this mean for you? New business
opportunities. With hemp and hemp-derived CBD federally
legalized, they are no longer subject to the provisions of Internal
Revenue Code 280E. This means companies engaged in the hemp
and hemp-derived CBD verticals can now take normal deductions
just like other businesses. This is a game-changer for many existing
businesses and opens a vast market for new businesses to enter.
GROWING YOUR PRACTICE
Currently, there are more than 500 hemp cultivation licenses issued
in Illinois and more are on the way as the industry grows and Illinois
farmers seek a means for diversifying away from the state’s two
primary crops of corn and soybeans.
In order to grow or process hemp in Illinois, a company must be
licensed by the state and pay fees. All hemp grown in Illinois is
subject to lab testing to ensure its compliance with state and federal
laws. For example, the Illinois Department of Agriculture mandates
hemp with THC levels greater than 0.7 percent must be destroyed,
which has huge business implications.
I often ask my new farmer clients what it costs to grow a pound of
hemp. If I can even get an answer, I then ask how they do cost
accounting. That is when I usually get a blank stare or silence,
because 99 percent of hemp growers and hemp-derived CBD
producers simply have no idea how to do this type of accounting.
This is just one example of the many areas within the legal hemp
and hemp-derived CBD verticals that you can specialize in—think
farming and cultivation, transportation, processing (like turning the
plant in to CBD oil), manufacturing (like turning the hemp fiber in
textiles), retail, and more. If you can master a niche and become a
“VIP” (Valuable Expert, Instructor, and Participant) in that realm, good
things will happen for your practice.
I have found that attending local or regional industry events is the
fastest way to get immersed in this evolving space and identify
service areas to address. Despite the stigma associated with the
entire cannabis industry, what I can tell you from firsthand
experience is that serving the federally legal hemp and hemp-derived
CBD verticals carries less risk than serving medicinal or
recreational marijuana clients. What I can also tell you is that the
hemp and hemp-derived CBD markets are growing in Illinois and
the businesses operating in these spaces, along with the much
broader cannabis industry, are vastly underserved by CPAs due to
the nuances and complexities—and perceived risks—that come
with serving them.
The primary struggles of hemp and hemp-derived CBD businesses
revolve around deciphering complex tax codes, such as 471, 263A,
199A; not practicing or understanding cost accounting or farm
accounting; implementing GAAP; poor inventory policies,
procedures, and controls; no inventory counts or reconciliations;
new industry software; and navigating multi-entity issues and
industry consolidations. Something worth noting if you’re interested
in serving the broader cannabis industry is that many of the tools,
workpapers, and charts of accounts used to serve the federally
legal hemp and hemp-derived CBD markets transition over to state
legalized medicinal and recreational marijuana markets.
All things considered, there are services far beyond accounting,
audit, and tax that you can deliver to clients in these spaces. Think
CFO services to start, which could include the areas of HR and
compliance. In fact, compliance is often a significant pain point for
CEOs that costs their businesses thousands of dollars in fees and
penalties and sometimes even leads to license revocations or jail
time. These are all areas where you can establish your “VIP” status
and build a successful practice.
MORE TO CONSIDER
When it comes to federal taxation, you must truly understand IRC
471, IRC 263A, Sec. 199A, and farm accounting. Hemp growing is
defined as farming, meaning Schedule F can be used when filing
Form 1040. The IRS’ 90-page Farmer’s Tax Guide should be read
closely. You must also be able to determine whether cash or accrual
accounting is best for your client. In the most general sense, the
benefit of cash accounting is that it usually defers taxes, but I would
argue accrual accounting gives a more realistic picture of the
business and is better for cannabis-related businesses and their
needs for raising capital, determining valuation, complying with
audits, and strengthening their management reporting.
When you add in state and local tax and compliance matters, the
challenges hemp and hemp-derived CBD businesses face become
more complex. In my experience, there are no answers that apply
to all clients. Your goal must be to understand your clients’
individual businesses and be able to identify the different solutions
for their unique issues.
There are also many other federal and state regulations outside of
tax and accounting that you’ll need to stay current on if you want
to be a VIP to your clients. For instance, the U.S. Department of
Agriculture (USDA) oversees all hemp production. Rules are being
written and rewritten regularly, so make sure you are signed up
with the USDA to receive email updates. Similarly, the U.S. Food
and Drug Administration (FDA) regulates the use of CBD in
foods, supplements, and beverages and addresses issues with
packaging, labeling, advertising, and claims of medical benefits.
Even the U.S. Environmental Protection Agency and Department of
Labor are setting new standards and regulations relating to the
cannabis industry, which includes hemp and hemp-derived CBD.
While these agencies will not be addressing accounting or tax, their
decision will impact your clients.
With 46 states, including Illinois, having their own approaches to
hemp and hemp-derived CBD regulation, taxation, law, and
licensing, as well as county and city ordinances, there’s no way for
you to know all the rules everywhere. With that said, I encourage
you to at least know your own state’s rules and to keep in mind that
hemp and hemp-derived CBD are new and evolving industries for
federal, state, and local governments to address. I predict the IRS
will audit many hemp and hemp-derived CBD businesses in the
years ahead. So, if you dive in and get up to speed on all things
hemp, CBD, and cannabis, you stand to be an invaluable advisor
to clients, an advisor they can trust to steer them toward success
and away from the fates of early cannabis industry CEOs who faced
fines and worse for doing things the wrong way.